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Rotman Insights Hub | University of Toronto - Rotman School of Management

Can you sell consumers on a price surge?

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Nicola Lacetera

When the pandemic caused shortages of items like hand sanitizer, pharmaceuticals and home fitness products, some companies increased prices in response. Backlash ensued.

“Price increases generate a lot of uproar and discontent,” says Rotman professor Nicola Lacetera. “There is a sense that it isn’t just or fair in certain situations or for certain products.”

Lacetera notes that people are generally more in favour of government-mandated price ceilings and regulations over allowing the market to fully set the value of a specific product or service. But he, alongside research partners Julio Elías of the University of CEMA in Buenos Aires and Mario Macis of Johns Hopkins University, wondered how individual perception of sudden price increases would change if consumers were told about the economic benefit. For example, when a company increases the price of, say, an in-demand drug, few people might be able to afford it initially. But the high price could incentivize other companies to produce similar drugs at a lower cost. “That increases supply and creates more competition to drive the price down so that more people can afford the drug,” Lacetera says.

To test this theory, Lacetera, Elías and Macis developed a survey to gauge respondents’ preference of two scenarios.

In the first scenario, a product suddenly becomes in high demand and the manufacturing company increases its price five-fold; competing companies develop comparable products a year later, driving the price down and allowing 80 per cent of those in need of the product to obtain it.

In the second scenario, the government imposes a price cap, and a year later, no other companies have entered the market. So only half of customers looking for such a product are able to buy one.

Researchers further manipulated the scenarios by offering some respondents information about the positive trade-off of price fluctuations — lower prices and more access to products in the long run — while others had no information about the potential benefits of unregulated prices.

The majority of respondents — about 68 per cent — still preferred government-imposed price regulations. But when participants were made aware of the costs and benefits of both allowing and banning price surges, support for price increases increased by about 23 per cent.

“If we didn’t specify these economic consequences, the vast majority of people voted against unregulated prices and were in favour of some form of price regulation,” Lacetera says. “When we made these potential economic consequences more salient, a much higher share of the respondents expressed favour towards unregulated prices.”

Lacetera, Elías and Macis also asked respondents to share how morally acceptable they thought each scenario was, and found that offering more details about economic implications and benefits resulted in less extreme views. “Providing more information also reduces the visceral moral reaction to the market,” Lacetera says.

This research suggests favourable outcomes when companies inform their customers about why price increase are happening. Lacetera gives the example of how Uber communicates price surges on its app. “It’s saying that with higher prices, we’ll get more drivers on the road because they can make more money,” he says. “It’s best for everybody because people can get more rides.”

However, there are some scenarios — such as major weather events driving up the price of essential product or terrorist attacks causing transportation delays — where price surges are never acceptable, no matter how much information is provided. “For example, after a blizzard, [price surges cause] this perception that the companies are trying to take advantage of customers and the situation,” Lacetera says. Specifically, respondents said they would feel exploited and violated in these scenarios, the researchers found.

The degree of moral unacceptance also differs depending on the type of product experiencing a price increase. In their study, Lacetera, Elías and Macis asked respondents to consider four products: a pharmaceutical drug, treadmills, hand sanitizer and hand moisturizer. Respondents were most in support of unregulated treadmill prices (41 per cent), while only 22 per cent of supported unregulated drug prices. The more essential an item, the less tolerance consumers had towards price increases.

With platforms like Uber and Amazon increasingly relying on AI to modulate prices based on demand, there is pressure to develop technology that can account for extreme scenarios where price surges are unacceptable. Until then, humans need to be involved in the price setting decision to avoid moral outrage of price surges, with the tradeoff being a slower reaction time to market conditions.

There are other solutions. Lacetera says that governments could get involved by offering subsidies to companies, incentivizing them to innovate and develop new products so that consumers don’t take the hit. Vouchers could also be given to the public to purchase expensive drugs, for example. However, as Lacetera notes, it’s not an easy solution either. “Who’s paying for the vouchers?” asks Lacetera. “Who do you tax, and how much debt do you go in to subsidize? There is a price to pay to reduce prices, so to speak.”

Nicola Lacetera is a professor in the department of management at the University of Toronto Mississauga, with a cross-appointment to the strategic management area at Rotman and to the economics department.